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What To Do If You Can Not Pay Your Taxes?

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“If you can not pay,” goes the old saw, “you can owe”. That’s certainly the way the IRS looks at things. Every year, the IRS receives millions of returns from taxpayers who can’t pay what they owe before the April 15 deadline, and that amounts to tens of billions of dollars of taxes due each year. If you find yourself among the millions of Americans who can’t pay all or any part of what they owe, you have four options: (1).You can pay it off in installments, which millions of taxpayers currently are doing. (2).You can put it off until you have more money. (3).You can try to convince the IRS to take less than it wants. (4).You can file for bankruptcy in the absolute worst-case scenario. This post emphasize on the topic.

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The IRS doesn’t accept every offer that is made, but it is fairly pragmatic, and in recent years has reached agreement in almost 25 percent of cases. From where the IRS sits, receiving some of what it’s owed is better than receiving nothing. This acceptance rate is actually much higher when you consider that a third of the offers can’t be processed because they don’t contain all the information necessary to make them processible. The average settlement is around 13 percent of what is owed.

Whatever you do, don’t confuse filing with paying. More people get into hot water because they mistakenly believe that they need to put off filing until they can pay. If you’re one of the approximately 2 million non-filers that the IRS currently is looking for, file your return as soon as possible — even if you can pay only part of what you owe. Owing the IRS money is expensive, but owing money and tax returns is far worse! Although the interest rates the IRS charges are lower than what you’ll get on your credit card (IRS rates in 2008 were between 5 and 7 percent and are refigured every three months), interest compounds daily on the balance you owe, in addition to a late-payment penalty of half a percentage point per month. That kind of interest adds up quickly! If you haven’t filed your tax return, though, the IRS tacks on additional non-filing penalties of 5 percent per month, up to a maximum of 25 percent.

At first, the IRS comes after you through the mail. If you owe money, either from the findings of an audit or because you simply couldn’t pay it all on April 15, you’ll get four notices from the IRS at five-week intervals. If you don’t pay everything you owe on April 15, the fourth and last letter arrives by certified mail around Labor Day. That’s when things start to get ugly.

Many taxpayers freeze when they receive one of these notices and then place the unopened envelope in a pile to be dealt with when the cows come home or hell freezes over. Bad idea! Whether or not you’ve actually opened the envelope, you’re still responsible to respond to the requests inside, even if to tell the IRS that you can’t pay right now. If you fail to respond, your account is considered delinquent and is forwarded to the IRS Automated Collection System (ACS), which means you’ll start getting telephone calls demanding payment — at home and, if the IRS can’t reach you at home, at work, at your club, anywhere the IRS has a number for you. Although the IRS is trying to be a friendlier place, the collections are collections, and they want their money! If the ACS isn’t successful in getting you to pay up, your account may be transferred to an IRS revenue officer who will contact you in person.

Because the IRS usually has what it refers to as levy source information about you in its files, it has the option to place a levy on your assets or salary, or to simply seize your property.

Keep in mind that from the return you filed the IRS already knows where your income comes from and how much you make and has the right to get additional information about you from credit and governmental agencies, such as the Department of Motor Vehicles, passport agencies, and the U.S. Postal Service. It can make you pay in more ways than one. And every time you make a payment, the IRS makes a permanent record of your bank account.

To avoid that hassle, if there’s any way that you can get the money together, send a partial payment when filing your return, a partial payment with the first, second, and third notices, and the balance (including interest and penalties) with the fourth notice. When the IRS sends a bill for less than $100,000, you have 21 interest-free days to pay it. When the amount you owe is more than $100,000, you have ten business days before you’re charged interest.

The IRS must notify you of your right to protest a levy of your salary or property. You have 30 days from the date the IRS sends you a Levy Notice by certified mail to request what is known as a Collection Due Process Hearing.

Requesting An Installment Agreement

In some cases, people need more time to pay what they owe. If you need more time, you can request to pay in installments by attaching Form 9465, Installment Agreement Request, to your return or to any of the notices you receive. Then send it to the IRS Service Center where you file or to the center that issued the notice. You also can request an installment agreement by telephoning the IRS Taxpayer Services office at 800-829-1040. If you owe less than $10,000 and can pay off what you owe in 36 months, the IRS is required by law to grant your request to pay in installments. However, some strings are attached. During the past five years, you had to have filed and paid your tax on time. Even if this rule knocks you out of contention, the IRS has a new policy that automatically grants installment agreements when the amount owed is less than $25,000 and can be paid off in 60 months.

When you request an installment agreement, the IRS mails you an acceptance letter that tells you where to send the money. You won’t have to provide a financial statement, and the IRS won’t file a federal tax lien, which is no small matter, because a tax lien can affect your credit rating for seven years, even if you pay off your tax liability in a shorter period of time. There’s a $105 charge for an installment agreement ($52 if you pay by electronic funds withdrawal) and a $45 charge for either changing an existing agreement or reinstating an agreement that’s in default. If your income is below a certain level, you may qualify for a reduced fee of $43 to set up the installment agreement. Remember, if you set up one of these agreements, you’re committed to filing all your returns and payments on time.

If you can’t pay the full amount of your outstanding debt to the IRS, but can pay a substantial portion of it, you may be eligible to enter into a Partial Payment Installment Agreement (PPIA). In order to do so, you must provide complete and accurate financial information that the IRS will verify. This plan is subject to review every two years to see whether your financial situation has improved and whether you can make larger payments. It’s possible that the IRS could terminate the plan entirely and the full balance would become due. If you’re thinking that you may be a candidate for a PPIA, check with your local tax advisor, who can help walk you through the process.

Be careful not to fall behind on your payments, or you may have to apply for an installment plan all over again. The IRS allows you to make payments using a variety of methods. Checks, money orders, electronic fund transfers, and credit cards (but no postage stamps, please) are all acceptable forms of payment. You can use cash, but only if you pay in person at an IRS office (for safety and security reasons, we don’t recommend this latter method!). If you want to be sure you don’t fall behind on your payments, you can either pay by direct deposit (use Form 9465) or by payroll deduction (use Form 2159, available by calling the number on your notice or by visiting your local IRS office). If you can’t make a payment, contact the IRS. You stand a good chance of being able to skip a payment if you have a plausible reason. Although the IRS isn’t all that charitable, it reserves its wrath for taxpayers who ignore the agency.

Installments get trickier when you owe more than $25,000 or want to stretch your payments out for more than 60 months. You can either use Form 9465 or go straight to the IRS, either by mail, by phone, or even in person [a representative, such as an enrolled agent, a CPA, or an attorney, can make this request on your behalf]. When you owe this higher amount, you’ll need to file a financial statement listing your assets, liabilities, and monthly income and expenses, which is submitted on IRS Form 433-A, Collection Information Statement for Individuals. Use Form 433-A if you’re self-employed. For a business, use Form 433-B.

After reviewing the information you’ve provided, the IRS will recommend one of the following courses of action or a combination of them. The IRS may tell you to:

Make immediate payment by liquidating some of your assets

Obtain a cash advance from a credit line

Borrow against the equity in any assets you may have, such as your residence

Make an installment agreement

There is a fifth option:

If there’s just no way you can pay, the IRS will stop bothering you for the money. Yes, if you get the fifth option, the IRS will prepare Form 53, Report of Taxes Currently Not Collectible, and you’ll be off the hook — for a while. However, the IRS will contact you every 9 to 12 months for a new financial statement to find out whether your financial condition has changed. Remember, the IRS has ten years to collect what you owe before the statute of limitations on collections expires. Also keep in mind that just because the IRS isn’t currently collecting from you, interest and penalties continue adding to your unpaid tax.

You can appeal any rejection of a request for an installment agreement to the IRS Appeals Office. Although the IRS doesn’t have a specific form for this, you can try using Form 12153, Request for a Collection Due Process Hearing.

If you filed your return on time and enter into an installment agreement, the late-payment penalty gets reduced from 0.5 percent a month to 0.25 percent a month while you’re making your payments. The total late-payment penalty that can be charged can’t exceed 25 percent of the tax owed. On $10,000 of tax owed, this reduction amounts to a $25-per-month savings.

How To Make An Offer to IRS?

What if you think there’s no way you’ll ever be able to pay it all off? The IRS, believe it or not, often takes partial payment. First, you need to fill out Form 656, Offer in Compromise.

This nine-line form requires you to complete only three lines in addition to your name, address, and Social Security number. You merely check one of the three boxes in Item 6, which include “Doubt as to Liability” — “I do not believe I owe this amount” — to which you need to attach an explanation; “Doubt as to Collectibility” — “I have insufficient assets and income to pay the full amount” — to which you need to attach a complete financial statement (Form 433-A, or Form 33-B); or “Effective Tax Administration” — “I owe this amount and have sufficient assets to pay the full amount, but due to my exceptional circumstances, requiring full payment would cause an economic hardship or would be unfair and inequitable”— to which the financial statement must be attached. Unlike the application for an installment plan, this financial statement will be audited, not merely reviewed.

The 1998 law that restructured the IRS created two additional reasons for submitting an Offer in Compromise. They are known as the equity offer and the hardship offer. The equity option may be used when the collection of the full liability creates “such an inequity as to be detrimental to voluntary tax compliance.” Don’t laugh! We’re quoting directly from the law. The hardship offer may be submitted when full collection would otherwise create an unreasonable hardship. What qualify under this provision are situations where seizing or selling your assets or having to make payments would leave you without enough to pay reasonable, basic living expenses.

An Offer in Compromise is a matter of public record and, if accepted, may come with strings attached. You may have to agree that for a period of years, perhaps as many as five, you’ll pay more than you offered in the event your financial condition improves. An aging Joe Louis had to accept such terms, just in case he ever started earning millions again by going back into the boxing ring.

Who are candidates for Offers in Compromise?All types of taxpayers: senior citizens with few or no assets or in poor health, spendthrifts who earned large sums of money and squandered it, athletes and actors whose earning potential has diminished, casualties of downsizing, and people whose relatives are reluctant to leave them money because of their tax problems.

You can appeal an offer that is rejected. While an offer is pending, the IRS is prohibited from levying your salary or property. Use Form 12153 to request an appeal.
In 2006, the IRS instituted significant changes in the Offers in Compromise program. For offers submitted after July 15, 2006, the IRS now requires, in addition to a $150 application processing fee, a 20 percent payment with a lump-sum offer or the first installment on your proposed period payment offer. The $150 application fee and additional down payment is waived if the offer is based solely on doubt as to liability or if the income of the person making the offer is below the poverty level. Don’t be fooled by what you may have heard. The IRS is anything but a pushover when it comes to agreeing to accept less.

After many years of talking about it, in 2005, Congress finally acted to make it more difficult to discharge your debts in bankruptcy. The result is the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, which now applies a means test to determine whether or not you can completely wipe out your debts, or whether you’ll have to enter into a five-year payment plan. What does this act mean to you? If things are really dire, you may still decide that declaring personal bankruptcy is the only way out; however, now you’ll receive six months of credit counseling before you can apply. And, after you do file for bankruptcy, if you earn more than the median income for a family of your size in your locale, you may be required to repay a portion of your debts, including your unpaid taxes, over a five-year period. Although the provisions of this new law are definitely tougher than those provisions of the prior law, filing a bankruptcy petition still stops the IRS from garnishing your salary or seizing your property.

Of course, if your income falls below the median for a family of your size in your area, you can still file for a complete discharge of your debts, including unpaid income tax liabilities that are more than three years old. If you fall into this category, you’re still required to have six months of credit counseling prior to visiting the bankruptcy court. You can recover up to $1 million in damages if the IRS willfully violates the bankruptcy law’s prohibition against seizing your salary or property.

Even if your tax liability isn’t completely wiped out in bankruptcy court, as often happens, the IRS won’t have as much power over you anymore. For example: you don’t have to get IRS approval on an installment plan. If the bankruptcy court allows your repayment plan because the bankruptcy judge finds it fair and equitable, the IRS has to accept it.

Filing bankruptcy, in addition to being emotionally charged, has its pros and cons. Bankruptcy is a technical and difficult area of the law and one that you may not want to negotiate by yourself. If you find that you’re contemplating filing for bankruptcy, you may want to use the services of a competent bankruptcy attorney. Your choice of an attorney is key; you can find a list of bankruptcy attorneys through Martindale-Hubbell, an attorney database available at your local law firm, public library, or online at www.martindale.com.

Filing for bankruptcy is a drastic step. Before heading down that road, be sure to analyze your overall financial situation, level of debt relative to your income, and your current spending.

Making adequate provisions in the first place is your best defense against not being able to pay your tax bill on April 15. Routinely review your withholding allowances (Form W-4) to make sure that the proper amount of tax is being withheld from your salary. If you’re self-employed or have income that isn’t subject to withholding, you need to make quarterly estimated payments using Form 1040-ES.

About AuthorLie Dharma Putra

Putra is a CPA. His last position, in the corporate world, was a controller for a corporation in Costa Mesa, CA. After spending 15 years as a nine-to-five employee, he decided to serve more companies, families and even individuals, as a trusted business advisor. He blogs about accounting, finance and tax, during his spare time, and helps accounting students (around the globe) to understand the subject matter easier , faster. Follow him on twitter @LieDharmaPutra or add him to your circle at Google Plus Lie+

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